Dean Baker: Geithner's "reason" for rejecting bank bankruptcies is bogus

Economist Dean Baker raises some excellent objections to Treasury Secretary Geithner’s plan to “lend” an additional $1 trillion to banks and hedge funds and private equity firms (on a non-recourse basis… meaning the “loans” become gifts if the investments they buy go bad) to buy distressed assets from bankrupt megabanks.

His first objection is that $1 trillion “is equal to 300 million SCHIP kid years. Congress has had heated debates over sums that were a small fraction of this size.” Yet there has apparently been no serious consideration by Congress, the Treasury or the Federal Reserve of other options: “the Geithner crew insists that there are no alternatives to his plan; we have to just keep giving hundreds of billions of dollars to the banks.” Baker recommends funding “for the price of just a few A.I.G. executive bonuses” studies by renowned economists like (blog favorites) Simon Johnson and Joe Stiglitz. (One complaint about Baker’s article: Stiglitz, Johnson, Krugman et al. have already offered better plans than Geithner’s.)

A second objection is that even another $1 trillion may not even be enough. Taxpayers have already given banks about $700 billion. And the Federal Reserve has already given several trillion more. (No one knows the terms of the Fed gifts or even which banks received what, and even the TARP watchdog is clueless about how the $700 billion has been spent.) Megabanks' balance sheets are still opaque, so who’s to say whether even another $1 trillion will get these bankrupt banks lending again?

The Geithner plan is an effort to rescue the banks by using government funding to prop up the price of these bad loans to levels that will allow the banks to stay solvent. It is not clear that the plan is big enough to accomplish this goal, but that is the basic intention. If it doesn’t work, then presumably Geithner will come out with another TARP permutation that involves giving the banks even more money.

Baker’s biggest objection is that there’s likely a better solution — involving creditors of insolvent banks accepting less rather than being bailed out completely by taxpayers. Baker suggests that the bankers' “reason” for rejecting the bankruptcy option is disingenuous and their real motive is that they prefer a complete taxpayer-funded bailout to a capitalist-style bankruptcy in which investors take losses on their bad investments:

Geithner has supposedly ruled out the bankruptcy option because when he, along with Henry Paulson and Ben Bernanke, tried letting Lehman Brothers go under last fall, it didn’t turn out very well. Of course, it is not necessary to go the route of an uncontrolled bankruptcy that Geithner and Co. pursued with Lehman.

The government could set up an arranged bankruptcy under which creditors have accepted conditions in advance. While this may not be easy to negotiate, the government does have enormous bargaining power in pursuing such a deal. The creditors (other than insured deposits, which will be paid in full) of these banks may end up with nothing if the government just let the banks sink.

Posted by James on Tuesday, April 07, 2009